Follow Up

OK, Facebook Is Worth More Than $15, but Probably No More Than $25

Facebook has made some progress on the mobile front, but not enough to justify a $75 billion stock-market value. Veteran investor Carl Icahn wants a $4 dividend from Transocean and new board members. And strong earnings propel Thermo Fisher Scientific. Will it buy Life Technologies?

Thank You

Error.

An error has occurred and your email has not been sent.
Please try again.

February 2, 2013

We probably should have quit while we were ahead.

Barron's was one of the few publications that didn't buy into the hype before
Facebook's
FB -1.1779554059739168%Facebook Inc. Cl AU.S.: NasdaqUSD82.215
-0.98-1.1779554059739168%
/Date(1427835600246-0500)/
Volume (Delayed 15m)
:
19145238AFTER HOURSUSD82.2
-0.0150000000000006-0.01824484583105273%
Volume (Delayed 15m)
:
553513
P/E Ratio
73.40625Market Cap
232863799605.182
Dividend Yield
N/ARev. per Employee
1355150More quote details and news »FBinYour ValueYour ChangeShort position
initial public offering in May, writing skeptically twice about the company's huge valuation. We looked good when the shares (ticker: FB) subsequently tanked. But we essentially doubled down with a September cover story ("Still Too Pricey," Sept. 24, 2012) in which we argued that the stock, then trading around $23, was worth only $15.

That was a bad call because Facebook has rallied to $29.73, amid greater optimism on Wall Street about the social-networking company's mobile strategy and other initiatives, including a nascent search business and a gift operation. Facebook probably isn't heading back toward $15 anytime soon, but the stock certainly looks overvalued at its current level. In our view, it should be trading at $25 or less.

Investors now believe that Facebook will find ways ultimately to produce big profits from its more than one billion users, even if it takes years to do so. Thus, they're generally willing to overlook the lofty valuation of the shares and the company's heavy spending.

Facebook trades for 52 times projected 2013 earnings of 57 cents a share. And its price/earnings ratio is even higher—around 75—if that 2013 estimate includes the costs of the company's generous grants of restricted stock to employees, which may account for 25% of their pay. These factors trim expected net to 40 cents a share. The Street routinely ignores the impact of such compensation, even though it's very real. At $25, Facebook would be valued at more than 60 times estimated 2013 net, including stock-compensation costs, and almost 10 times expected revenue.

Facebook shares fell almost 6% last week, after the company reported fourth-quarter results showing a 40% increase in revenue to $1.6 billion and pro forma profits of 17 cents, two cents above expectations. The stock came under pressure because Facebook unexpectedly said that its operating expenses would rise a greater-than-expected 50% in 2013 as it plows cash into product-development projects for mobile advertising and other businesses. The disclosure prompted analysts to trim their estimates for 2013 profits by about a nickel per share

Citigroup analyst Neil Doshi cut his rating to Neutral from Buy, citing Facebook's planned spending and "little expected contribution from new initiatives" this year, like gifts and search. He also wrote in a client note that "mobile ads appear to be cannibalizing desktop [advertising], which further concerns us."

As its user base has rapidly shifted to smartphones, tablets, and other devices, Facebook has developed a mobile advertising business that generated $306 million in revenue in the fourth quarter, up from just $45 million in the second. On the company's earnings conference call last week, Chief Executive Mark Zuckerberg proclaimed that "Facebook is a mobile company" with huge opportunities in that area.

The rest of Facebook's business, however, is showing slower growth, with desktop-ad revenue rising just 9%, to $1 billion, in the fourth quarter from the year-earlier total. Some of the concerns raised in our cover story remain valid, including potentially less user engagement on mobile devices, relative to the desktop, and the question of whether mobile ads will alienate users.

Zuckerberg deserves credit for quickly repositioning the company for mobile. But Wall Street looks overly bullish in betting that a still nascent mobile-ad business with an annual revenue run rate of $1 billion will produce enough growth to justify Facebook's $75 billion stock-market value. That seems like a big stretch.

Transocean (ticker: RIG) now pays no dividend and is spending money to buy new rigs. Normally, this wouldn't make sense because its stock trades at $56, below its net asset value of more than $70. A big payout would reduce temptation for management to do a large acquisition. And the company, which has $6 billion in cash, certainly can afford the dividend, which would amount to roughly $1.4 billion. In a note to Barron's, the company was noncommital about its dividend plans.

Carl Icahn wants a $4 dividend and new directors.
Bloomberg News

Until recently, that cash was needed as insurance against any adverse decisions in the litigation surrounding the 2010 Gulf of Mexico oil spill, which occurred in a well
BPBP -1.8323293172690762%BP PLC ADSU.S.: NYSEUSD39.11
-0.73-1.8323293172690762%
/Date(1427835688484-0500)/
Volume (Delayed 15m)
:
6156679AFTER HOURSUSD39.11
%
Volume (Delayed 15m)
:
24790
P/E Ratio
28.295470988279554Market Cap
120552648348.742
Dividend Yield
6.136537969828688% Rev. per Employee
4167260More quote details and news »BPinYour ValueYour ChangeShort position
(BP) was drilling with a Transocean rig. But this year, Transocean settled, for $1.4 billion, civil and criminal claims brought by the Justice Department. And BP is believed to be indemnifying the company for most civil claims by states and companies as a result of the spill. The civil cases are slated to go to court this month.

Still, Jerry Furciniti, a portfolio manager at QCI Asset Management, would prefer that Transocean reduce its $14 billion in debt and fund its expected $3 billion in capital outlays this year before making a decision on a dividend. Furciniti, who was bullish on Transocean when we last wrote about it ("Ready to Rise From the Depths," Dec. 3, 2012), still likes the stock despite its 23% surge in the past two months.

He expects oil prices to stay firm, lease prices for deepwater rigs to keep improving, and the stock to hit $75 by year-end, in part because he sees Transocean earning north of $6 a share in 2014. Icahn's presence certainly doesn't hurt, either.

Rob MacDonald, an associate portfolio manager at Thornburg Investment Management, which holds the shares (TMO), notes that Thermo threw off a record $1.77 billion of free cash flow last year. He thinks the stock, now $74.78, is worth $96—16 times the roughly $6 a share analysts expect Thermo to earn in 2014.

Thermo is up about 36% since we wrote favorably about it ("Brainy Stock, Bright Prospects," April 30, 2012), as domestic sales have stayed steady and the Waltham, Mass., company has made inroads in emerging markets such as China.

One issue remains unclear: whether Thermo, as has been rumored, will acquire
Life Technologies
(LIFE), which makes laboratory equipment for medical research. But deal or no deal, Thermo is well-positioned for steady earnings growth, even in a challenged global economy.